Investors to Avoid for Your Pre-Seed Round
Investors to Avoid for Your Pre-Seed Round
Part 5 of the “How to Raise a Pre-Seed Round” Series
This week we’re going to get into Part 5 of the “How to Raise a Pre-Seed Round” Series: How To Find Investors for Your Pre-Seed Round Without a Network
How to Raise a Pre-Seed Round Series
❗ Part 5: Investors to Avoid (this post)
Some sources of capital seem almost too good to be true. As with most things in life, if it seems too good to be true, it probably is.
When it comes to pre-seed raises, a few sources of capital stand out, in particular, that should be approached with caution: Grants, Angel Groups, Accelerators, Equity Crowdfunding, and Non Pre-Seed VCs. In general, these sources of capital require investing a lot of time for not a lot of money. Time and effort that could instead be spent raising from individual Angels, Micro VCs, and more traditional investors.
However, there are certain cases where these sources of capital do make sense. Here’s how to think about and assess these sources of capital.
Equity Crowdfunding
In 2019, we evaluated Republic, the most popular equity crowdfunding website, to see if it was a good fit for our startup. I analyzed all the pre-seed companies that had raised so far (first time raising and at under an $8M cap). This came out to 32 companies, and the average they raised was $122,000.
$122,000 isn’t bad, but a successful crowdfunding campaign requires a lot of time and money. I’ve heard it takes a month or two of full-time work to put the campaign together. Then once it is live, it becomes a full-time job marketing it and responding to questions. I’ve also heard that it can cost tens of thousands of dollars to market the campaign. If you put that same time and effort into finding investors, I think you would be able to raise more than $122k.
Where equity crowdfunding does seem to work well, is for companies with large and engaged customer bases already. However, pre-seed companies, by definition, usually don’t have large and engaged customer bases.
Angel Groups
Angel groups are groups of angels that have a set investment process. Angel groups are distinct from individual angels, which are great sources of capital. Angel groups often seem like they are a good place for a first round. But in reality, they often want more traction than most VCs.
By the time you have that traction, you should raise from a VC. VCs are much more likely to help you, and they don’t have the stigma that comes with angel groups. Below is a chart that outlines the fundamental problem with angel groups.
If an angel group interests you, do your due diligence. How much traction did those companies have when the angel group invested? What types of companies have they invested in? If they have companies that have had big exits, when and how did the angel group invest?
Beware of the portfolio pages
Equity crowdfunding and angel groups, in particular, will often list very successful startups on their website that have “raised from them”. However, it is important to know when and how the companies raised from them.
Very often, they are private, late-stage deals made outside of their normal process. Hint: those companies didn’t use the same process they’re pitching you. Republic, for example, does a great job of showing how these deals were private and growth stage.
Accelerators
The problem with accelerators is that many want a good chunk of equity, with little to show for it. Other than YC and Techstars, few successful startups have come out of accelerators. Even between YC and Techstars, there is a significant difference in their alumni valuations. For some, this may come as a surprise that there are accelerators other than YC and Techstars, but if you’re a pre-seed founder, you’ve likely come across dozens of accelerators most people have never heard of.
The reason most accelerators aren’t helpful is simple: accelerators are often run by people who don’t know what they’re doing. Often the leaders have never founded or invested in a company outside of the accelerator, so they ended up providing advice that sounds right but is actually wrong. YC Partner Aaron Harris accurately summarized the accelerator landscape below.
I think the number of accelerators is proliferating faster than the number of startups. This terrifies me because most of the people who are advising companies in accelerators have no idea what they’re doing. They’ve never worked at a startup, they’ve never started a startup, they’ve never funded a startup outside of the accelerator. You’ve got to ask yourself why on Earth should I take advice from this person who’s never done any of the things that they’re telling me I should do, never seen any of these things work?
If you are looking at an accelerator, talk with founders who’ve recently gone through it. Ask them what they thought of it, how much they raised, and if they would do it again.
Incubators and various other startup programs
Incubators are not a source of capital, but they are worth noting. They are often one of the first organizations founders come across. Usually, incubators provide a combination of education, mentorship, and networking. Incubators are like accelerators but without an investment. Despite not being a source of capital, they often frame themselves as a way to access investors.
I participated in many incubators and programs for startups and left disappointed. The leaders of those programs never made an intro that led to funding or helped with the raise. More often than not, their advice was actually incorrect and counterproductive. I saw many other founders participating have similar results. Ironically, Erlich’s incubator in HBO’s Silicon Valley is actually much better than most real-life incubators.
But, I wouldn’t say you should not take part in incubators. Despite the official programs being of little value, the founders I met in those programs were great. They provided intros that led to some of our biggest investments, so indirectly, incubators can actually be a good source of capital but not necessarily in the way they pitch themselves.
Grants
Grants are very industry-specific. For some industries like defense, for example, grants are more plentiful and substantial. But, even in industries where grants are viable, the applications can take a long time to complete. Often it takes even longer to actually receive the funds.
The last kicker with grants is that the funds are often earmarked and require you to do things you don’t want to do. If you decide to go the grant route, make sure to dig into the details before going down that path.
Non Pre-Seed VCs
Despite having good relationships with some non pre-seed VC firms, they never invested nor made intros that led to investments. They were helpful with other things like providing feedback on the deck, but not when it actually came to intros that converted.
If you think a non pre-seed VC is interested, work to move the conversation along quickly to see if they are interested in investing now. Often, when VCs meet with you, they are just looking to get to know you to possibly invest down the road. They aren’t actually interested in investing at your current level of traction.
Closing Thoughts
Your time is your most valuable resource when fundraising. Grants, Angel Groups, Accelerators, Equity Crowdfunding, and other sources of capital often frame themselves as a good source of initial capital for pre-seed startups— and they can be for some startups — but they also often carry hidden baggage. Make sure to do your homework before investing your limited time in these sources of capital.
If you’re wondering what types of investors you should seek out, check out this article on how to find individual Angels, Micro VCs, and other sources of capital for pre-seed rounds.